Saturday, December 15, 2007

Fed Statements Coming Back To Haunt Them?

Repeatedly your blogger suggested that the Fed's credibility might take a blow during this financial crisis, without more aggressive efforts to manage market expectations.

I suggested that they hold in Oct, but signal high levels of responsiveness. That would have paved the way for a "shock and awe" 50 bps cut in December with a similar signal that the Fed is prepared to move rapidly. If they held in Oct, it is unlikely that the market would have been expecting 75 bps.

When they disappointed the markets in Decemeber they should have made mention to the strong GDP numbers in Q3. Let the market know that they see the future but we are in fact coming out of a rapid expansion and the Fed has to be sensitive to that.

Instead we have had a series of confusing statements and moves.

I do not envy the FOMC, Bernanke in particular. They are facing what may be the toughest challenge since the Great Depression. However, I do think that now is not the time to experiment with transparency.

Now is the time to offer statements that will serve to boost market confindence.

Now is the time to say that we are prepared to act rapidly when bad data comes in. Remind the market that the Fed takes employment and output to be the variables of interest, not asset values. However, as threats to employment and output materialize there will be a strong and vigilant response.

We can probably expect data that supports, what everyone believes to be true by mid January, thus implying that the Fed will move strongly in Jan and March to relieve stress to the real economy.

By the bye Nouril Robini is starting to convince me. More one that later.

15 comments:

TGGP said...

A commenter at Austrian Economists brought to my attention this from Tyler Cowen on rules vs discretion for maintaining reputation in a second best world.

Jeff said...

It is possible that the best policy is one problem, and the explanation is another.

As one who has worked at a top university, with a top government team, and with an excellent group of traders, I am frequently amazed at how little respect each group has for the other.

In this case, we might consider the possibility that the Fed knows what they are doing.

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